Why Employers Self-Fund Benefits
Six Primary Reasons Employers Decide to Self-Insure (Self-Fund) Employee Benefits
- Reduced insurance overhead costs. Self-insurance eliminates the risk charge that carriers assess for insured policies (approximately 2% annually.
- Reduced state premium taxes. Self-insured programs, unlike insured policies, are not subject to state premium taxes. The premium tax savings is about 2% per year in Washington State.
- Choice of state mandated benefits. Self-insured plans are exempt from most state insurance laws, although both insured and self-insured plans are governed by Federal law (predominantly ERISA). ERISA allows a self-insured employer more flexibility in the design of their benefit program, whereas Washington State benefit mandates add considerably to the cost of insured employer benefit programs.
- Benefit plan control. The self-insured employer can simply instruct their independent claim administrator to revise insured benefits. Typically, employers must negotiate with carriers over benefit changes and the associated cost or savings. In an insured plan, the carrier may be unwilling or unable to make the desired change. Self-insured employers have benefit plan control.
- Cash flow. Self-insured programs offer cash flow advantages over insured policies, particularly in the year of adoption when "run-out" claims are being covered by the prior insurance policy.
- Choice of claim administrator. Employers can choose to have either an independent third party administrator (TPA) or an insurance company administer their plan. The employer gains greater cost competition, choice and flexibility. Conversely, only an insurance carrier can administer an insured policy.
How much do employers typically save with a self-funded model?
On average, an employer can save 4% to 12% per year, depending on the differences between insured and self-insured benefit plan design and on the level of stop-loss insurance chosen. Also, in years when actual claims are less than expected, the employer saves the amount of the surplus. In years when actual claims are higher than expected, the self-insured plan cost may exceed an insured plan premium. Note that savings depends entirely on the group of people to be covered.
What are the downsides to self-insurance (self-funded plans)?
The primary shortcoming of a self-funded plan is the volatility of monthly costs. However, having proper stop-loss coverage amounts generally limit the possibility of large annual cost fluctuations. Be aware, even with stop-loss insurance, the employer assumes greater risk than with an insured policy. Volatility can put greater demands on budgeting and monthly cash flow.
When Self-Funding, Also Consider:
Premium rate equivalents. Also called accrual rates or pseudo premiums, the self-insured plan must calculate its own rates on which to base employee contributions, COBRA rates and budgeting. Good TPAs and EmSpring can help!
Annual reporting requirements. The employer will be responsible for filing annual reports, such as 5500s, Schedule As, and 990Ts. Some brokers like to do these for you, but it's usually best to have your own independent CPA involved.
Administration. While the employer retains final authority for benefit design and claims payment issues, the day-to-day administration of the plan can, and should, operate in the same manner as the insured policy. The stop-loss insurer approves and the TPA adjudicates claims according to the employer's plan document.
Trusts. Alternatively called a 501(c) (9) trust or VEBA, trusts allow employers to establish and maintain reserves and more easily avoid co-mingling of employee contributions with company assets. The employer is not required to set up a trust to operate a self-insured benefit plan.
Accounting and reserving. On an insured policy, the insurance carrier retains the claim run-out liability (claims incurred prior to the policy end date but paid after that date). Under a self-insured plan, this liability shifts to the employer. This “payable" at fiscal year end must be calculated and recognized on the company financial statements. The employer can set up a cash reserve in a VEBA to offset this liability, but reserving is typically no more than a journal entry.